Is Profit the Same as Cash Flow?

is-profit-the-same-as-cash-flow

Overview 

One of the biggest challenges facing an entrepreneur is the management of cash flow. It’s never easy to get an accurate estimate of when your customers will pay.

On the other hand, when payments will be received is difficult to guess.  Business owners spend too much time handling cash flow and ensuring that they are in a position to fulfil all their financial commitments.

Many businesses have found that the process of factoring or selling their invoices or accounts is an effective way of changing sales in receivable cash.

Using the services of a factor, business enterprises can improve their liquidity position as well as avoid the inconvenience of collecting the amount due to their customers.

Is Profit the Same as Cash Flow

The physical movement of cash within or outside the business is known as cash flow.  The companies generally receive money from the customers and use it to meet the day-to-day petty expenditures and payments that the company has to make in cash.  

In today’s business environment, the use of money is replaced by digital business transactions and therefore the physical movement of cash or flowing money has been reduced to a large extent.

Importance of Cash Flow

Though most business transactions are done online still the importance of cash can not be ruled out.  The inflow and outflow (cash flow) are quite important for the smooth running of any kind of business. The company has to receive cash for small or petty sales or sometimes for big sales when the customer doesn’t have a cheque or a digital payment facility.  

On the other hand, the company has to maintain cash as per their requirements for meeting day-to-day petty expenses and making payments to the suppliers or service providers who either don’t have any bank account or only accept payment in cash.  

Proper cash flow management is essential for any kind of company not only to meet day-to-day expenditures but it is also a part of financial statements and balance sheets. Preparing the cash flow statement is mandatory for public limited companies.

What are the Categories of Cash Flow

There are three most popular categories of cash flow viz: 1. Investment cash flow2. Operating cash flow 3. Financing cash flow: 

1. Investment Cash Flow 

Cash inflow or outflow from short-term or long-term investments in bonds, securities of other companies or corporations and dividends or interest received thereon.

2. Operating Cash Flow

Operating cash flow is the cash movement by a company’s regular operating activities in the specified period.

3. Financing cash flow

Financing cash flow refers to the funds generated by a company for financing activities in a specified period. It includes payment of dividends and repayment of equity.  And raising funds by equity or debt will be incorporated in the cash flow statement.

Is it Mandatory to prepare a Cash Flow statement?

 

is-profit-the-same-as-cash-flow 

All businesses are supposed to prepare and submit three mandatory financial statements a prescribed intervals including a cash flow statement. This is a part of the income statement and balance sheet and is mandatory for Public Company Financial Reporting (PCFR) needs w.e.f 1987.

Cash Flow Ratio and its Importance

A company’s remaining quantity of cash after paying all the capital and operating expenses. This refers to the cash that a company holds after payment of rent, salaries of employees, taxes and other expenses to be met by cash.  

The proper maintenance of cash or control of the inflow and outflow of cash (cash management) in the company helps the company to invite investments as it reflects the sound financial position of the company by timely payments of bills and other expenses.

Effects of Cash Flow on Business

As stated above cash flow plays a very important role in any kind of business. If the company does not maintain sufficient cash that company has to lose some important business transactions because it will not be able to buy goods or services for which the supplier or service provider accepts only cash.  

The business houses will also be in a position to meet their petty expenditures.  On the other hand, the company will lose customers who do not have bank accounts or any other mode of digital payments. Therefore, even in today’s business world, the effects of cash flow can not be ignored.

What is the Positive and Negative Cash Flow?

Positive cash flow means your business is getting more cash from different businesses and other transactions than outflow of cash. This means the inflow of cash is more than the cash outflow. This shows that the business is in a healthy position and able to meet all cash expenditures well in time.  

In contrast, negative cash flow tells that the availability of cash at a particular time is not good and the business is not in a position to meet its required cash expenses in time. This will certainly have a negative impact on the goodwill and business of the company. Therefore,  it is very necessary to maintain a balanced cash flow for a sound business.

How does the cash flow portion work?

When a business sells a credit, the payment is usually due in a 30, 60, or 90-day period, within a predetermined period. Typically, the seller must wait one month or more to get cash against the sale. But funds for a business can be urgently needed. 

In such a situation, one factor is to buy an invoice and pay the seller immediately. In the general course, the amount paid will be approximately 80% of the invoice value. After this, on the due date, the factor will collect the entire amount from the buyer. At this time, the factor has to pay the remaining 20% invoice value to the seller after deducting his charge.

is-profit-the-same-as-cash-flow

Who should use cash flow?

Some categories of businesses can not use factoring. Any business that sells at the retail level will not be able to take advantage of this means of financing because the factoring requires credit sales. Businesses with sound credit ratings generally do not use this method of fundraising. They can use the finance at those rates which effectively cost much less than a factor fee. 

Factoring is extensively used by firms that have large amounts of business-to-business sales on credit. Significantly, factoring services are not dependent on the credit rating of the company selling its invoice. Instead, the buyer’s rating is important. It allows new firms and businesses to raise funds using factoring with bad credit ratings.

Portion gives great convenience

Another factor is that factoring has gained great popularity with small businesses, this is the easiest with which funds are provided to the vendors of goods and services. A business can get money within 24 hours of the invoice for the factor in its bank account. 

In addition, this involves very little paperwork and the seller does not have to worry about the employees of their credit and collection department because this work is controlled by the factoring company.

Some precautions

Although factoring can provide great benefits for a small business, before deciding which factoring company to use, it is advisable to take some simple precautions. If your business sells goods on a refundable basis, avoid using one factor. It can be tough to sort out the complications that may result from the cancellation of the invoice for the returned goods. 

While factoring offers a lot of conveniences, it can become an expensive source of finance. A little research on the terms and conditions offered by different companies can save you a lot of money.

Difference between Cash Flow and Revenue

The income generated by the sale of goods or services during a particular period is called revenue for that period whether received or not whereas the goods or cash flow represents the actual cash inflow or outflow of cash by the sale of goods or services, cash expenses or other cash receipts. 

CONCLUSION  

The physical movement of cash within or outside the business is known as cash flow. Though most business transactions are done online still the importance of cash can not be ruled out. The inflow and outflow (cash flow) are quite important for the smooth running of any kind of business.  

Factoring is extensively used by firms that have large amounts of business-to-business sales on credit. Significantly, factoring services are not dependent on the credit rating of the company selling its invoice. Instead, the buyer’s rating is important.  It allows new firms and businesses to raise funds using factoring with bad credit ratings. 

If the company does not maintain sufficient cash that company has to lose some important business transactions. Therefore, even in today’s business world, the effects of cash flow can not be ignored. Though managing cash inflow and outflow is very difficult and unpredictable every company has to cope with this position.  

The companies manage the cash inflow and outflow by the way stated above and also by way of bank overdraft and other ways depending on the size and nature of the company. Thus, keeping proper control of cash inflow and cash outflow is very important for every company and must be taken prime care of by the management.